Utility stocks are shares in companies that provide essential services such as electricity, gas and water. People keep paying their energy and water bills in good times and bad, so these businesses tend to have steady earnings. That is why utilities are often called defensive stocks, the part of the market investors turn to when they are worried about the economy.
Who the main players are
In the UK, well-known utility shares include National Grid, which owns and runs much of the country’s electricity and gas transmission network, SSE, which generates and distributes power, and water companies such as Severn Trent and United Utilities. In the US and Europe there are many more, from large power generators to regional networks.
Why they are seen as defensive
Demand for electricity, gas and water barely changes with the economic cycle. In a recession, people may cut back on holidays or new cars, but they still turn on the lights and run the taps. Many utilities also operate under regulation that sets how much they can charge and what return they can earn, which makes their profits more predictable.
That stability lets many utilities pay reliable dividends, which attracts income investors. In market sell-offs, utilities often fall less than the wider market.
Why interest rates matter so much
Utilities have two big sensitivities to interest rates. First, they borrow heavily to build and maintain networks, power stations and pipes, so higher rates raise their costs. Second, investors often compare their dividends with the income available from government bonds. When gilt yields rise, the dividends on utility shares look less attractive by comparison, and their share prices can fall.
That is why utilities are sometimes called bond proxies. With the 10-year gilt yield above 5 per cent and the UK Budget on Wednesday 28 October, UK utilities are among the shares most exposed to any move in government borrowing costs. Our Morning Market Brief covers where yields stand.
The risks
Regulation cuts both ways. A regulator can limit price rises or demand more investment, squeezing returns. UK water companies have faced intense pressure over leaks, sewage spills and debt, and some have struggled financially, which shows that defensive does not mean risk-free.
Energy transition is another factor. Utilities are investing heavily in renewables and grid upgrades. That can create growth, but it also requires huge amounts of capital, which may mean more borrowing or raising money from shareholders through a rights issue.
The rush to build data centres for artificial intelligence has also created a new story for some utilities, especially in the US, because those centres need enormous amounts of power. That has turned a few traditionally dull shares into growth stories, with the extra volatility that brings.
The bottom line
Utility stocks offer steady demand and reliable dividends, which makes them a defensive corner of the market. But they are highly sensitive to interest rates and regulation, so understanding where bond yields are heading is essential before investing in them.
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